Retroactive or back pay refers to income owed to an employee from a previous pay period. Retroactive pay may happen for a number of reasons, such as incorrect salary compensation or wages for hours worked, or a pay increase. Whatever the reason, as a small business owner, you’re supposed to ensure that the respective employee receives the correct amount of retroactive pay.

Determine Hours Paid

Before you begin computing the actual amount due for retroactive pay, you must first figure out what the employee actually received. For example, during the last weekly pay period you compensated the employee for 35 hours, but she should have been paid for 40. On the upcoming weekly payroll, pay the employee for five hours plus all hours worked in the current pay period.

Figure Hourly Rate

After computing the number of hours due, determine the rate of pay you’re supposed to pay them at. For example, compensate regular hours at the employee’s regular hourly pay rate and overtime back pay at his overtime rate for the pay period the retroactive pay is effective. For example, if the employee is owed five regular hours from the previous pay period and his pay rate for that pay period was $10 per hour, compensate the five hours at that rate, which would equal retroactive pay of $50.

Compute Retroactive Salary

To arrive at retroactive amount for a salaried employee, subtract what she was paid from what she should have received. For example, she normally receives $2,000 biweekly; however, in the prior pay period she received $1,800. This means that she’s due retroactive pay of $200.

Retroactive Pay Increase

If an employee receives a pay increase that is effective in a prior pay period, the difference between what she was paid and should have been paid is his retroactive pay. For example, he used to earn $11 per hour. He received a pay increase of $1 that was effective in the last two biweekly pay periods in which he worked 80 hours each. This means that he was paid 80 hours each biweekly pay period at the old rate of $11 when he should been paid at $12 per hour. Multiply the pay rate difference of $1 by 160 hours (80 hours x 2 pay periods) to arrive at retroactive pay of $160. Pay his hours for the current biweekly pay period at the new rate of $12.

Considerations

If the employee agrees to it, you can pay retroactive earnings on the upcoming paycheck. You may also pay it on a separate paycheck from her earnings for the current pay period to decrease tax-withholding liabilities. Specifically, because taxes are generally based on the amount an employee earns, if you lump retroactive pay with regular earnings, she’s likely to pay more in taxes.